Tax Evasion

The great lie of supply-side economics.

In American politics, supply-side economics is the monster that will not die. The supply-side argument that, in the United States, tax-rate cuts pay for themselves—that, after cutting taxes, the government actually ends up with more revenue—has little or no support within the mainstream economic profession, and no hard empirical data to back it up. Myriad studies demonstrated that both the Reagan tax cuts of the nineteen-eighties and the tax cuts put through under the current Administration shrank government revenues and led to bigger budget deficits.

Yet the absence of proof for supply-side theory has not dimmed Republicans’ devotion to it. Last month, President Bush told Fox News that his tax cuts had “yielded more tax revenues, which allows us to shrink the deficit.” Dick Cheney insists that “sensible tax cuts increase economic growth and add to the federal treasury.” Every major Republican Presidential candidate—including John McCain, who actually voted against Bush’s 2001 tax bill—is on the record as saying that tax cuts pay for themselves. And, just last week, a New York Sun editorial published a list of what “the Republican Party stands for.” First on the list? “Reductions in top marginal tax rates . . . lead to greater government revenues in the long run.”

This supply-side orthodoxy is striking in a couple of ways. First, it requires Republican politicians to commit themselves publicly to a position that is wrong—and wrong not as a matter of ideology or faith but as a matter of fact. Saying today that tax cuts will increase tax revenues is not like saying that bombing Iran constitutes a sensible foreign policy, or that education vouchers will wreck the public schools. It’s more like saying that the best way to treat sick people is to bleed them to let out the evil spirits. Second, despite the fact that the supply-side faith has no grounding in reality, within the Republican Party there is little room for dissent on the subject, as Jonathan Chait details in his new book, “The Big Con.” Last week, the blogger Megan McArdle wrote that she had a book review for an unnamed right-wing publication spiked because in it she dared suggest that, in the U.S., tax cuts decreased government revenues.

The cynical explanation for the persistence of the supply-side dogma is that it’s simply cover for cutting taxes for the rich. But the supply-side orthodoxy has flourished for other reasons, too. To begin with, the absurd idea that tax cuts pay for themselves is based on an idea that is not at all absurd, which is that tax rates can have an impact on people’s behavior. Increase taxes too much, and people may work less (since they get to keep less of the income they earn) and invest less (since their gains will be taxed more heavily), and so the economy will grow more slowly. The opposite can happen if you cut taxes. (How much of an impact tax rates have—and how high taxes have to get before they have an impact—is a subject of much debate in economics, but it’s inarguable that they do matter.) What supply-siders have done is start with that reasonable idea and extrapolate it to unreasonable lengths.

They’re aided in that extrapolation by the simple fact that the American economy grows over time. As a result, even if you cut taxes the federal government will eventually take in more tax revenue than it once did. And that allows supply-siders to fashion a spurious syllogism: taxes were cut in 2001, government revenues are higher in 2007 than they were in 2001, therefore the tax cuts increased revenue. The comparison that really matters in analyzing the impact of the tax cuts, of course, is not between government revenue in 2001 and government revenue in 2007. It’s the comparison between actual tax revenue in 2007 and what tax revenue would have been in 2007 had there been no tax cuts in 2001. And studies that make these types of comparisons—including one by Bush’s own Treasury Department that looked at the tax cuts’ impact on economic growth—find that government revenues would be greater had taxes not been cut. But that hasn’t stopped President Bush from claiming victory.

In one sense, of course, it’s odd that a Republican President should treat higher government revenues as a point of pride. Historically, after all, Republicans have been the party of small government and fiscal restraint. But, while Republicans still talk a good game about the need for spending discipline, in practice it matters far less to them than tax cutting. After all, if tax cuts pay for themselves, then there’s not much reason to worry about restraining government spending—we can afford it all. In fact, if government spending grows too big, you can cut taxes again to pay for it.

The conservative pundit Larry Kudlow recently attacked the Republican candidates for failing, in their most recent debate, to explain what spending cuts they would advocate to accompany the tax cuts they propose. But Kudlow should hardly have been surprised, because supply-side rhetoric suggests that spending cuts aren’t really necessary. You can let people keep more of their income and increase government spending at the same time. This tax-cut-and-spend approach is the promise of a free lunch, something that voters like to hear. The appeal of that promise may make it easier for politicians to run a campaign. But the fraudulence of the promise makes it awfully hard to run a government. ♦